Capital Burden of U.S. Bank Exams Could Rise, Tarullo Says

Fed's Tarullo: Some Capital Requirement Increase Coming
  • Fed governor says still unclear how rules will be toughened
  • Rules on counterparties and pay possible for early next year

Large U.S. banks will probably have to endure tougher scrutiny of their capital to pass annual stress tests, Federal Reserve Governor Daniel Tarullo said.

There’s “more than a pretty good chance” that banks will face “some net increase in the post-stress minimum capital requirements,” Tarullo said in an interview Monday with David Westin and Stephanie Ruhle on Bloomberg Television. Such a step could result in banks having to hold more capital to be allowed to pay dividends to their shareholders.

The Fed hasn’t decided how it will toughen the stress tests, but it could be through incorporating capital charges in the exams or by drilling down on exposures to other financial firms and trading partners, said Tarullo, who is the central bank’s point person on regulatory matters. Tarullo’s comments Monday were his strongest yet indicating that the Fed is likely to take such action.

The Fed in July assigned capital charges totaling more than $200 billion for eight of the biggest U.S. banks, including JPMorgan Chase & Co. and Citigroup Inc., to reduce the risks they could pose to the financial system. The extra capital requirements, or surcharges, range from 1 percent to 4.5 percent of banks’ risk-weighted assets.

High Stakes

Maintaining that added capital could be challenging under the hypothetical economic slumps the Fed uses in its stress-tests, prompting industry concerns that it would be even harder to get a passing grade. The stakes are high, because lenders that fail face restrictions on buying back stock and paying dividends.

For banks, having the surcharge included in the exams would be a “significant burden, particularly because of the interplay of the other rules coming into effect," said Karen Shaw Petrou, managing partner of Washington-based research firm Federal Financial Analytics. She cited a regulation the Fed proposed last month on loss-absorbing capital that banks must hold.

Petrou said the added capital requirement would likely be included in the 2017 tests and not the next round whose results will be released next year.

The central bank is looking at how it can strengthen what he called the “macroprudential element” of the tests, or the impact one bank’s losses could have on financial stability. Banks have been subjected to the exams, which are aimed at determining whether lenders can survive a severe economic downturn, since 2009.

Biggest Banks

Tarullo emphasized that the Fed is focusing its regulatory attention on the largest financial institutions that could put the economy at risk if they were to fail. Regulators continue to look at ways they can simplify rules and supervision for regional and small banks whose failure would be unlikely to threaten the financial system, he said.

Tarullo also said Fed rules required under the Dodd-Frank Act on counterparty credit limits and executive pay could be completed early next year. The regulation on counterparty credit imposes limits on banks’ exposure to loans and derivatives, while the pay rule restricts compensation arrangements that might incentivize bankers to take undue risks. Those regulations won’t likely require “dramatic shifts” for banks because they have already made many of the necessary changes, Tarullo said.

“The incentive compensation systems at our large institutions are like night and day compared to what they were pre-crisis,” he said.

The Fed also has been working on a measure to restrict banks’ ownership of physical commodities such as oil and coal, though he noted that many firms “have pulled back or disposed of their commodities operations.”

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